tango_gs

When would the asset-based approach result in a higher valuation than its going concern value, in the case of private company valuation?

A) When valuing pharmaceutical firms.

B) If the firm has minimal profits and poor prospects.

C) When valuing biotech firms.

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If a firm has minimal profits and little hope for better prospects; it might be valued more highly for its liquidation value than as a going concern if another firm can put the assets to better use. Because the asset-based approach values firm equity as the fair value of its assets minus the fair value of its liabilities, it would capture this liquidation value.
Pharmaceutical and biotech firms have a high degree of intangible assets. In these cases, the going concern value is likely to be higher than the value from the asset-based approach.

tango_gs

The asset-based approach values a firm based on:

A) fair values.

B) book values.

C) investment values.

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The asset-based approach values firm equity as the fair value of its assets minus the fair value of its liabilities.

tango_gs

Which of the following is most accurate regarding the asset-based approach? Of the three valuation methods for private firms, it usually:

A) is not difficult to apply.

B) is the most appropriate for going concerns.

C) results in the lowest valuation.

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The asset-based approach is generally not used for going concerns. Because it is easier to find comparable data at the firm level compared to the asset level, the income and market approaches would be preferred to value going concerns.
Because it is difficult to find data for individual intangible assets and specialized assets, the asset-based approach can be difficult to apply. It generally results in the lowest valuation because the use of a firm’s assets in combination usually results in greater value creation than each of its parts individually.

tango_gs

Which of the following statements related to the market approaches to private company valuation is most accurate:

A) The prior transaction method (PTM) is based on price multiples from the sale of whole public and private companies.

B) The guideline public company method (GPCM) is based on price multiples from comparable traded firms.

C) The guideline transactions method (GTM) is based on historical stock sales of the actual subject company.

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The guideline public company method (GPCM) approach to private company valuation uses price multiples from traded public companies with adjustments for risk differences. The guideline transactions method (GTM) uses the price multiples from the sale of whole public and private companies, again with adjustments for risk differences. The prior transaction method (PTM) uses historical stock sales of the subject company; it works best when using recent, arm’s-length data of the same motivation. (Study Session 12, LOS 43.i)

tango_gs

A minority equity interest in a private firm is being valued where a discount for lack of control will be applied. The analyst will use a market approach and comparable data from other firms. Which of the following is the valuation method the analyst is using?

A) The guideline transactions method.

B) The prior transaction method.

C) The guideline public company method.

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In the guideline transactions method (GTM), the comparable price multiple data is for the sale of entire firms where control is acquired. Because the subject transaction is for a minority (noncontrolling) equity interest, a discount for lack of control (DLOC) is applied.
In the guideline public company method (GPCM), the comparable price multiple data is from noncontrolling interests, so no control adjustment would be made to this data if this was the method used.
In the prior transaction method (PTM), transactions are from the stock of the actual subject company, i.e. the data are not from other firms.

tango_gs

An analyst is valuing a private firm on the behalf of a strategic buyer and deflates the average public company multiple by 15% to account for the higher risk of the private firm. Given the following figures, calculate the value of firm equity using the guideline public company method (GPCM).

Market value of debt	$4,100,000
Normalized EBITDA	$42,800,000
Average MVIC/EBITDA multiple	8.5
Control premium from past transaction	25%

The value of the firm’s equity is closest to:

A) $382,438,000.

B) $304,060,000.

C) $385,200,000.

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The adjustment to the MVIC/EBITDA multiple for the higher risk of the private firm is: 8.5 × (1 − 0.15) = 7.225. Given that the buyer is a strategic buyer, a control premium adjustment should be made: 7.225 × (1 + 0.25) = 9.031.
The adjusted multiple is applied against the normalized EBITDA: 9.031 × $42,800,000 = $386,537,500.
Subtracting out the debt results in the equity value: $386,537,500 − $4,100,000 = $382,437,500.

invic

A private pharmaceutical firm is under consideration for acquisition where the financial buyer will pay with equity. Part of the payment to the sellers is based on FDA approval of the firm’s drug. If the analyst uses a market approach and comparable data from public firms, which of the following would most likely result in a price-multiple that is too high? The comparable data is:

A) from transactions where the buyer used cash.

B) for strategic buyers.

C) for transactions where the consideration was non-contingent.

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In market approaches, the analyst values the subject private firm using price multiples from previous public and private transactions. A strategic buyer is one who will have synergies with the target whereas a financial buyer does not. A financial transaction typically has a smaller price premium. So in this case, the comparable price-multiple will be too high.
If the acquisition involves the acquirer’s stock, the acquirer may be using overvalued shares to buy their target. Using comparables where cash is the consideration would result in lower price multiples.
Contingent consideration is payment to the sellers based on the achievement of specific goals such as FDA approval. Contingent consideration increases the risk to the seller and ceteris paribus, they would demand a higher price. Using comparables where the consideration was non-contingent would result in lower price multiples.

invic

Which of the following statements related to the models used to estimate the required rate of return to private company equity is most accurate:

A) The CAPM model uses betas estimated from firm returns of other private firms.  

B) The expanded CAPM model adds premiums for size and firm-specific risk.

C) The build-up method begins with betas for comparable public firms and adds risk premiums.





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Expanded CAPM adds premiums for size and firm-specific risk. CAPM may not be appropriate for private firms because beta is usually estimated from public firm returns. The build-up method adds an industry risk and other risk premiums to market rate of return; it is used when betas for comparable public firms are not available. (Study Session 12, LOS 43.h)

invic

Using the following information, calculate the WACC using the build-up method, assuming the firm is being acquired.

Income return on bonds	6.0%
Capital return on bonds	2.0%
Long-term Treasury yield	3.5%
Beta	1.4
Equity risk premium	6.0%
Small stock premium	4.0%
Company-specific risk premium	3.0%
Industry risk-premium	2.0%
Pretax cost of debt	11.0%
Optimal Debt/Total Cap	20%
Current Debt/Total	7%
Debt/Total Cap for public firms in industry	33%
Tax Rate	30%

A) 17.7%.

B) 18.5%.

C) 16.3%.

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Using the build-up method: the risk-free rate, the equity risk premium, the small stock premium, a company-specific risk premium, and an industry risk premium are added together: 3.5% + 6.0% + 4.0% + 3.0% + 2.0% = 18.5%. Note that the risk-free rate is the Treasury yield, not the returns for bonds in general.
Because the firm is being acquired, we assume the new owners will utilize an optimal capital structure and weights in the WACC calculation. The capital structure for public firms should not be used because public firms have better access to debt financing.
The WACC using the optimal capital structure factors in the debt to total cap, the cost of debt, the tax rate, and the given cost of equity:
[20% × 11% × (1-30%)] + [(1-20%) × 18.5%] = 16.3%.

invic

Using the following information, calculate the required return on equity using the expanded CAPM.

Income return on bonds	6.0%
Capital return on bonds	2.0%
Long-term Treasury yield	3.5%
Beta	1.4
Equity risk premium	6.0%
Small stock premium	4.0%
Company-specific risk premium	3.0%
Industry risk-premium	2.0%
Pretax cost of debt	11.0%
Optimal Debt/Total Cap	16%
Current Debt/Total	7%
Debt/Total Cap for public firms in industry	33%
Tax Rate	30%

A) 15.9%.

B) 18.9%.

C) 11.9%.

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The required return on equity using the CAPM is: 3.5% + 1.4(6%) = 11.9%.
Note that the risk-free rate is the Treasury yield, not the returns for bonds in general.
Using the expanded CAPM, a small stock premium and company-specific risk premium are added: 11.9% + 4% + 3% = 18.9%.